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Health reform and the individual mandate

September 16th, 2011

By Thomas D. Snook

Thomas Snook

This post originally appeared on the Society of Actuaries blog.

Two prominent physicians at Johns Hopkins recently made comments supporting the individual mandate provision in the healthcare reform law. Just a few days later, the 11th Circuit U.S. Court of Appeals struck down the provision, ruling it unconstitutional. While the decision is seen by most as just a way station on the way to the Supreme Court, it does point to the sensitive nature of the provision.

As actuaries, we can’t help but see the mandate a little differently than either physicians or judges. Regardless of our political views—and if you’re wondering, mine happen to be independent, moderate, and centrist—our professional expertise tells us that in the absence of underwriting and other traditional insurance risk management provisions, something is necessary to address adverse selection. The individual mandate may offer that something—as I indicated almost two years ago in a paper co-authored with Ron Harris. Without it, the sustainability of private health insurance is at risk.

What is meant by “adverse selection”? Adverse selection is simply people acting in their own economic self-interest. Health insurance is not cheap, especially if you don’t have an employer subsidizing some or all of the cost. The purchase of health insurance is a significant financial commitment that thoughtful people will weigh carefully in light of other economic needs. (Many commentators, including the Hopkins physicians, refer to those going without health insurance as “free riders”; I find this phrase to be unfortunate, as it is simplistic and pejorative without recognizing the economic realities that families face in making this decision).

Consumers will place a value on health insurance commensurate with their perceived need for it. People with immediate healthcare needs are going to naturally place a higher value on insurance compared to those who haven’t seen a need to go to the doctor in a few years. When the cost of health insurance is relatively low, such as in an employer-subsidized plan, the choice is easier: almost everyone will opt in. But when the cost of health insurance is higher, the choice is not so straightforward. Some people will opt in, while others will decide to risk it, at least for a while.

Those who opt in are going to be the ones who place the higher value on insurance. Those people are more likely to have immediate healthcare needs and hence be more expensive than the population as a whole. This is how adverse selection drives up health insurance costs. The higher the costs, the higher the premium, which then circles back on the individual coverage decision—a higher premium means even more individuals will opt to go without coverage. Taken to its logical conclusion, we wind up with an insurance pool that may be unsustainable.

The traditional techniques used by insurers to mitigate this risk have included denying coverage or charging higher premiums for individuals with preexisting health conditions, or excluding those conditions from the individual’s policy—things that have been necessary to preserve the viability of health insurance programs, but also things that have been wildly unpopular with the public in recent years. These techniques are one reason why private health insurance is viewed so negatively by certain segments of the American electorate.

In response, the Patient Protection and Affordable Care Act (PPACA) takes these traditional risk management techniques away, or significantly limits them. Instead, it offers two tools to manage the adverse selection risk: coverage subsidies and the individual and employer mandates. Instead of reducing the number of unhealthy individuals entering the insurance pool, this approach tries to maximize the number of healthy lives getting coverage. The subsidies are available to lower-income Americans to help make the coverage choice easier, more like those of us who have employer-subsidized plans have. And the mandates are there to provide penalties to those who still opt out from coverage. The idea is to make it attractive to get insurance, and unattractive to go without—thereby influencing the individual coverage decision I described above.

Will it work? We’ll have to see. Some point to the efficacy of the mandate in Massachusetts as proof that a nationwide individual mandate will work (for a Massachusetts-commissioned analysis, click here). Some (myself included) believe the mandates may be too weak to be effective nationwide, and that adverse selection may have a significant impact come 2014. Others dislike the subsidies because they are expensive, and the mandates because they believe they impinge on civil liberties. It is this latter point, of course, that is the subject of the lawsuits challenging the constitutionality of the PPACA.

While the future of the law in general and the individual mandate in particular may rest with the courts, it’s hard to dispute that something needs to fill the risk mitigation vacuum since the PPACA has taken the old techniques off the table. This is one case where the legal arguments will clearly trump the actuarial arguments, but that doesn’t make the actuarial concerns go away. Market rules that turn a blind eye to adverse selection simply won’t work.

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